Roth Conversion: What It Is and Why It May Be Right for You
Filed under: Retirement
Do you own a traditional IRA but think a Roth may be a better option? You’re not alone. The Roth IRA has become an increasingly popular savings vehicle. That popularity is driven largely by its unique tax treatment, which allows you to take tax-free distributions in retirement and leave a tax-free asset for your loved ones.
Not everyone can contribute to a Roth IRA, however. Roth contributions are governed by income limits. If you’re a high earner, you likely haven’t been able to put money in a Roth. The traditional IRA doesn’t have income limits for contributions. Your traditional IRA contributions may not be deductible if you have high income, but that doesn’t mean you can’t contribute.
Of course, this can create a challenge if you have high income but want to take advantage of the Roth’s tax-free distributions. Fortunately, you have another option available. You can convert your traditional IRA assets into a Roth IRA.
A Roth conversion could help you minimize your tax liabilities in retirement and help you enjoy more financial stability. It isn’t for everyone, though. There are some important points to consider before you move forward with a Roth conversion. Below are a few tips to keep in mind as you explore this strategy:
The biggest question many people have about the Roth conversion is how the transaction actually works. Essentially, you move your money from your traditional IRA into a new Roth account. Below are the three most common methods for doing so:
Rollover. In this option, you take a distribution from your traditional IRA. Your traditional IRA trustee then sends you a check. It’s important that you don’t deposit this check or use it for any purpose other than funding your new Roth IRA. When you open your Roth account, you simply deposit the traditional IRA funds. If you complete this within 60 days, the transaction counts as a conversion. If you take more than 60 days, however, or if you use the funds for another purpose, you could face taxes and penalties.
Trustee-to-Trustee Transfer. This option is usually simpler than the rollover method. In this option, you fill out conversion paperwork with the new trustee for your Roth, who then contacts the traditional IRA trustee to facilitate the transaction. The funds are transferred directly between trustees, eliminating the risk of missing the 60-day window or using the funds for another purpose.
Same-Trustee Transfer. Perhaps the easiest option is to use the same trustee for your Roth that you use for your traditional IRA. In this scenario, you simply fill out paperwork with your financial professional, and the trustee adjusts the classification of the funds. It’s usually a quick process with little risk of error.
Roth Conversion and Taxes
The other big consideration is how the conversion will impact your taxes. Obviously, the Roth will provide tax-free income in the future, which could be helpful in retirement. However, the conversion could also have present-day implications.
Distributions from traditional IRAs are taxable, and a Roth conversion isn’t exempt. You will have to pay taxes on any deductible contributions and growth converted into a Roth. You do not pay taxes on any nondeductible contributions. You will not face early distribution penalties if the conversion is executed correctly.
Also, it’s important to note that you must be age 59½ and hold the Roth for at least five years before taking tax-free distributions. If you plan on taking withdrawals before age 59½ or within five years, you may want to think twice before converting your funds.
Ready to explore your retirement funding options? Let’s talk about it. Contact us at Ambrose Financial & Insurance Services. We can help you analyze your needs and goals, and then create a strategy. Let’s connect soon and start the conversation.
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